State Street Corporation (STT) Earnings Call Transcript & Summary

Good morning, everyone, and thanks for joining. My name is Rob Wildhack, and I'll be reading our discussion today. I'm delighted that we have Ron O'Hanley and Eric Aboaf from State Street joining us. Ron has been the CEO since 2019, and prior to that, was President and CEO of State Street Global Advisors. Eric is State Street's CFO and has held that role since 2016. Before we get going, just a couple of housekeeping items to highlight, first [Operator Instructions] And with that, Ron has some prepared remarks to kick us off. So I'll turn it over to him. Ron, please go ahead.

Thanks, Rob, and good morning, everyone. Just to remind our audience that today's discussion may contain some forward-looking statements. And that actual results may differ materially from those statements due to any number of the -- any of the important factors, including the risk factors in our Form 10-K and our SEC filings. Our forward-looking statements speak only as of today, and we may not update them, even if our views change. And with that, this morning, I would like to start by briefly outlining where we have come from as an organization. And as we look ahead, I'll detail my strategic vision for State Street, including my 3 strategic priorities for this year. After that, Eric will join me for the fireside chat with Rob. During 2020, we all witnessed the devastating human impact of the pandemic as well as an economic shutdown, historic market volatility and a radical shift in working and living conditions. With the continuing rollout of vaccines, there is positive momentum in the U.S. and many other developed countries. At the same time, COVID-19 infection rates and death rates remain stubbornly high in many parts of the world, and as a global organization with 29 locations around the world, our thoughts are particularly with our team members and their families in India. From a macroeconomic perspective, we are far removed from where we were around this time last year. Economic activity is rebounding, unemployment is declining, and equity markets have recovered strongly from the crisis levels experienced last year. While short-end interest rates remain at historically low levels, long-end U.S. bond yields have risen in expectation of the economic recovery ahead. Looking back pre-pandemic in 2018 and 2019, we were faced with the challenge of successfully reinvigorating our core asset servicing business in the face of several industry headwinds. Simultaneously, and partially in response to these headwinds and challenges, we embarked on an ambitious strategic pivot from our traditional role as a fund servicer to also becoming an enterprise outsourced solutions provider. We acquired Charles River Development in late 2018 and began the development and implementation process of State Street Alpha, our full front-to-back client value proposition. Concurrently, in the near-term and in the long-term, we also needed to embrace -- we needed to address inefficiencies within our operating model by more rapidly embracing technology, automation, and productivity initiatives to drive down expenses. Having implemented a number of actions and organizational changes in 2018, to address these industry headwinds, while also successfully reducing total expenses ex notable items and CRD that year, we entered 2020 with a similarly aggressive agenda to further execute against the multiyear strategic goals that I just mentioned. With significant operations in China, we were dealing with the virus outbreak early on in 2020. As it firmly established itself as a global pandemic by March of last year, our strategic agenda looked under threat. We needed to keep our employees safe, manage the day-to-day impacts of the pandemic, deal with record volumes and deliver for our clients. Despite the challenges that the pandemic presented in 2020, we were able to continue to execute on our ambitious strategic pivot. First, we continue to progress Charles River Development and State Street Alpha, delivering key technology, particularly the cloud data platform and align front, middle, and back office servicing. We also signed 6 new Alpha mandates. Second, we redefined and began implementing our strategy for institutional services, which remains the core engine of our -- of growth within our business. And third, at State Street Global Advisors, we continue to develop products and client solutions, which led to strong organic growth and expanding margins. As I look back to 2020, I'm extremely proud of the way our team delivered. We successfully navigated a number of significant challenges, while simultaneously executing on our strategic agenda as we drove down total expenses ex notable items. And while record low interest rates have impacted the timing of our medium-term targets, we recently reconfirmed that they are the right ones for our business, and I am confident we will continue to innovate our clients' needs and drive business growth, while also focusing on improving productivity to achieve our goals. As I look ahead to support our strategic vision, I am focused on 3 priorities this year, which include: one, increasing our fee revenue growth rate; two, transforming the way we work; and three, building an even higher-performing organization for the future. First, we are prioritizing further fee revenue growth this year by improving our client engagement and sales effectiveness, advancing our innovative suite of products and capabilities, and continuing to position our asset management business for growth. Taking a moment to further elaborate on fee revenue growth, we are focused on a multipronged approach: one, Alpha; two, client segments; three, regional coverage; and four, client coverage by size. Starting with Alpha, we are continuing our intense innovation with further software and operational development and delivery of the front-to-back Alpha offering, which continues to gain traction with clients, as evidenced by a number of new wins that you have seen recently. Because of the platform's open architecture design, we have been able to rapidly increase functionality by adding a number of partnerships to our platform, unlocking new sources of revenue, and enabling greater flexibility and choice for our clients. We are also focused on delivering an enhanced client segment strategy, covering asset managers, asset owners, insurance, alternatives, and official institutions. Each of these client segments has its own needs and challenges, which require relevant client solutions to address them. We have already seen progress, for example, in alternatives, where we have enhanced our offerings and technology solutions, which in turn is driving revenue. Next, our regional approach will assist us in areas where we have more work to do as we implement refreshed local strategies with increased regional accountability for growth. Lastly, building on the success of the Global Client division's coverage model for our top 50 clients, we are refreshing our client coverage model strategy and are rolling it out in the next group of clients, which now will cover our top 350 clients. Together, we expect these strategies will result in State Street Alpha and other institutional services wins across the franchise, as we improve our sales effectiveness and broaden and deepen client relationships across segments and regions. As Global Advisors, we remain focused on driving further growth within all 3 segments: institutional indexing, SPDR ETFs and cash, each of which are amongst the world's largest, have scale and are growing. We continue to focus our efforts on product development and growing market share with key areas of opportunity being cash, ETF and ESG capabilities. Our second key priority for 2021 is transforming the way we work as an organization. The pandemic highlighted many strengths across our operating model, which we are institutionalizing to drive even better results for the years ahead. By automating repeatable processes, we will be able to redeploy our people to higher value-add roles, which, in turn, we expect will lead to greater productivity and more innovation as well as reducing cost to serve our clients. We are leveraging the lessons we have learned throughout the pandemic as we rollout our workplace of the future plan, which includes hybrid work models, new approaches to real estate and new ways of collaborating with clients and employees. Looking ahead, we will continue to build on the success we've achieved from our transformation initiatives to further reduce inefficiencies and drive true productivity gains across the organization. Our third priority is to build an even higher-performing organization. Just as we are changing our strategic direction as an organization, we need to shift our performance culture to achieve the type of success that we want. As we continue to simplify the organization, we are further incentivizing behavior that drives strong results and higher client and employee engagement satisfaction. We have already upgraded talent in key positions, and we will foster an even stronger results driven and accountable culture that further delivers results for our clients and for our shareholders. To conclude, we are on the journey of strategically pivoting our business from the traditional role as a fund servicer to also become an enterprise outsourced solutions provider, underpinned by State Street Alpha and a comprehensive refresh of our institutional services strategy. We have demonstrated our ability to execute on ambitious strategic agendas, even in the face of significant challenges. In 2020, we successfully demonstrated our ability to adapt rapidly to change while continuing to innovate and execute. As we look ahead, we are focused on 3 strategic priorities for 2021: growing revenue, transforming the way we work, and building an even higher-performing organization for the future. And with that, Rob, I'll hand it back to you for some Q&A.

Excellent. Thank you very much, Ron. That was a great overview. And maybe I'll start where you've started, because, a year ago, this question would have been quite a bit different. But as we sit here 12 or 15 months from the onset of the pandemic, walk us a bit about your experience as the CEO, a major player in the financial ecosystem. What was that like? And what did you learn about your business and your employees?

Well, I think for many of us that were around during 2008, we thought that was the signature moment of our careers, if you will, but I suspect that the pandemic will at least equal that, if not eclipse it. I think there were really 3 things that we learned about ourselves. Some of them were confirmatory, some of them were truly new learnings. First is, we actually are a very resilient organization, and the crisis demonstrated the depth of our operational capabilities. It illustrated our ability to take on volumes that really nobody had ever anticipated. Some of the peak volumes, and I'm not just talking about securities volumes, but the underlying transactions were actually many, many standard deviations beyond what we saw before. And the operation performed, and it held together. Second learning is -- which is really somewhat confirmatory and somewhat new is, our clients have a much broader set of needs that they expect us to be able to fulfill. We've seen this before, many of the pressures that are on our clients have translated into some of the things that I talked about in my remarks in terms of our clients want to see us be able to provide them with outsourced activities. The pandemic, if anything, turbocharged that. Many clients saw, for the first time, real shortcomings in their operation or, in fact, were confirmed for them what the shortcomings were in their operation. Some of it was true operational and technology. Some of it was around areas they hadn't expected to see shortcomings, such as around portfolio liquidity. And we all know, I mean, it seems like a distant memory now, but the -- those few weeks in mid- to late March and even into the 1st of April, and some of the liquidity concerns were quite dire. And then the third thing that was absolutely refreshing about State Street was just the incredible ability for the team to deliver. And I just can't say enough about this. The agenda was and continues to be ambitious. We often get asked, are we trying to do too much? And yet, we executed what we said we were going to do last year, some of which is very quietly and on time despite what we needed to do and in addition to what we needed to do to keep our employees safe, to meet the needs of our clients, to move the better part of 90% of 39,000 employees to remote work and to maintain them there. So in my view, the learnings, for the most part, been good learnings, reinforcing what we've seen before and positioning us well for the future.

Right. And I want to stick with the client perspective there because, as you noted, clearly, a lot of shifts in client behavior and activity, which ones of those do you see as more permanent versus more temporary? And then how does that shift create opportunities for State Street?

Yes. So the -- we had seen, Rob, largely as a result of the headwinds that we all -- everybody in this audience knows about that the investment industry is facing. I mean if you think about -- this is not an old industry, right, depending on where you measure its start. I mean it's certainly under 50 years old. And it is -- most of its life has been one of tailwinds, market tailwinds, new product tailwinds expanding -- just an expanding group of investors to move from individual security ownership to portfolios. All of that was a gigantic headwind for the -- tailwind for the industry. The last 10 years has mostly been about an increasing -- the increasing impact of headwinds. The -- while financial markets continue to grow, in fact, you're not seeing those anywhere near the same kind of fund formation. And in fact, in many cases, you're seeing fund deformation as distributors want to work with fewer fund managers and even there with fewer funds. Alpha has become more and more elusive. Distribution cost have risen, and distribution kind of shelf space has become dear. Technology costs and the need to deploy technology amongst asset managers and asset owners has gone up. So if anything, those were there, and I think just got magnified during the crisis. If you had a problem in your operation in normal times, it was clearly going to become more so then. And I think it forced a really significant examination on the part of clients in terms of what is it that's important for them to do versus to have somebody else do. And so it did -- after a brief pause in the kind of March, April, early May time frame, in fact, we saw more interest and help us outsource, help us figure out what to do. And what's interesting about this, Rob, is the way I'm describing it. You might draw the conclusion that it's just those firms that are in trouble or struggling with their margins. It's interesting to me that some of the most successful investment firms in the world are actually coming to us often from a different position because what they're saying is, "We can afford to do this ourselves, but it's not where we should be spending our time or our management share of mind," right? And what they're getting out of this is the ability to future-proof new -- their operations future-proof their technology. Couple of other things that actually also occurred during the crisis that I think will be -- I don't think it occurred to clients as much, but I think will be there long term, is this idea of liquidity. You saw, particularly amongst asset owners, really dire situations that I don't think they'd expect it to be in. Many public funds in the U.S. are basically the way they run their portfolios are, they have a permanent portfolio, if you will, but they're paying benefits through cash flow. That cash flow wasn't there. And you saw very big pension plans moving down to single days, numbers in terms of cash available. So the idea of, how do you think about low-cost and sensible and low-risk kind of portfolio liquidity, I think will be something that stays with us. And then finally, I think what will be -- what was new to them, but I think will be relevant going forward, is this idea of remote work. I mean few asset managers were prepared for it, even few of our clients were prepared for it. And that, again, goes back to, is your operation and technology actually able to provide that kind of flexibility for remote work. So will this be -- $64,000 part of your question is, is it temporary or permanent? I think these things always have some element of permanence just because the minds are seared in terms of what happened during the time. So I expect it will accelerate trends that we've seen happening before that, and we expect to continue for a longer term.

Got it. And maybe just to stick with the outsourcing and new business, sort of catalyst for new business as drivers for you. With first quarter earnings, you mentioned the need to execute on your sales pipeline, can you just expand on what you mean there? And what do you think, if anything, has been lacking in terms of execution?

Yes. That's a good question. It goes back to, as I talked about, our strategic priorities for 2021. I think there's 2 elements to that. First, to the Alpha offering. What we've learned now since we launched this in earnest kind of post the Charles River acquisition is, these are long sales cycles, really long sales cycles. In some ways, that's understandable because we're very, very seldom. I can't think of one, where we've been responding to an RFP, but it's more been a either a discussion with an existing client or a new client. And I would describe it not as a sales cycle, but as a solutioning cycle. As we've built up a track record here, and now we've got 16 of these signed, we've -- we're learning how to shorten that sales cycle. Again, clients are different. And we've certainly shown that there's a -- even with those 16, a fairly rich mix of asset managers, asset owners, medium-sized, large, et cetera, but there are certain things and certain kind of phases of the solution cycle are common. So part 1 of my answer to you is, this idea of how do we more standardize and routinize the Alpha solutioning cycle so that we can shorten and start our onboarding. And then the second, again, was what I talked about when we talked about segments and geographies is, is just being much more process-driven around how we operate in the segments outside of asset management. As you know that our -- we operate across many segments, but our largest segments, by far, is asset managers. And for that, it's the large asset managers. And what we tried to do -- or what we're doing and have done over the last couple of years is bring that same kind of intensity to the other segments that I mentioned. What do I mean by that? First of all is, starting with the offering. And in several cases, we've actually tuned up the offering. In Alternatives, we actually have a new technology platform, state-of-the-art that we've implemented last year. In asset owners, we've added to our own existing platform with a couple of partnerships. Second, beyond the offering is, how we approach the marketplace? So we've got now segment owners that are highly focused on articulating and delivering the value proposition to that segment. And then lastly, we've significantly strengthened our regional strengths, our regional capabilities. And if you think about it, there's lots of things that are in common, and that's what's great about this business. So technology and product changes that we make for asset owners, for example, if it's driven out in North America, actually, to a large degree, can extend around the world. But in terms of that accountability for either selling to existing clients or selling to new clients, we just needed to strengthen the regional element to that network has been underway now for the past 1.5 years with lots of new people in place, new process in place. So we're pleased with the progress so far.

And Rob, I'd just add, what we've done is, we've supported the sales and coverage force with a set of MIS that really helps them find the opportunities. So part of it is, imagine the segments, the regions, right, so there's -- that's a grid of performance. And you add to that another dimension of relationship management side, the top 50 clients, the next 100, the next 200. And so within that, we have a very clear view of performance, right? In addition to what we've overlaid over the last 2 years is, our share wallet assessment, because a lot of the data is relatively public or can be imputed. So we understand our position in each of those cells or areas of opportunity. And then we've refined our account planning process so that we know what we're going after, what we're trying to accomplish, where we're focused on retention versus sales versus prospecting and so forth, and we kind of do it all the way through that grid. And it's that level of execution that we're really looking for because, while the backdrop is potentially a wave of outsourcing, right, outsourcing comes in waves, and we know that front office and middle office, in fact, is still only 25% outsourced, so there's a lot of upside. But even back into the chain of fund accounting and custody, the real opportunity is when you get down to that level of granularity. And that's kind of a shift towards execution that we've seen has been very effective with our largest clients. We initiated that in 2019, and we've talked about how that's driven faster growth than average for the company. And so we're expanding that to another level of specificity where we see real opportunities.

Right. And maybe to stick with areas of opportunity, I'd like to jump over to the State Street Alpha business. Talk to us a bit about the strategic merit of that product and the value proposition that a front-to-back offering has for your clients?

Yes. I mean if you think about it from the client perspective, you've had for the most part an industry that's grown up where, for any firm that's got kind of any tenure in the industry, much of their operations and even a significant amount of their technology was proprietary. And it wasn't viewed as key to what an asset manager needed to do. First was, investments. Second was, clients, both serving existing and attracting new. As time went on, a new asset class typically brought a new operation, and oftentimes, new technology. So you had situations where older, more established firms, multi-asset, would oftentimes have multiple order management systems, a plethora of risk management systems, all sorts of pre and post trade kinds of processes in place. So the value proposition here, first and foremost, is about modernizing all that and to be able to kind of skip over the intervening generations and modernize it. The second is, around data. And data really is the -- ultimately, the key buying factor for clients. And it's a combination, not so much of a shortage of data, but how do you manage data and how do you ensure its integrity? I mean if you think about what happens to data from the pre-trade, I'm thinking about making this investment all the way through the process to when it gets reported back to your clients, that data gets transformed. And for the most part, it's basically unusable in terms of injecting that back into the investment process. And increasingly, clients are looking for that, the ability to be able to shed a lot of that reconciliation and to be able to rely on that data that's coming out of the back and use it in the front. I mean, one very, very easy example is cash availability. I suspect that, everybody on this call has lots of different ways that they're looking at cash availability. Some of that manual and some of that in a little bit of a pencil-driven kind of sheet that's on the side of their desk. So it's -- this really is about being able to manage that data and bring that data back to the portfolio manager in a timely way. It's also about, as I've noted, eliminating the cost that's existing there. And two, in effect, variabilize the cost of operations and lower the fixed costs. And again, it's not like -- it's not that every firm is in trouble and can't afford to do it, but it's a little bit of -- that's not the strength of an investment firm. An investment firm is about investing well and serving its clients well. For the Alpha value proposition is being able to take that front, middle and back office operations and be able to integrate it seamlessly into the investment process, but to also make sure that there's a future-proofing of what's going on that, that data is available and that the upgrades continue as opposed to facing a step function change sometime in the future.

Got it. So it sounds like opportunities on -- to do some unique things on the data side and also help clients on the cost side, too. I want to switch over to the core asset servicing business. Eric, in the past, you've talked about the growth algorithm here as being plus 2 percentage points from each of markets, new business and client activity, typically, offset by 2 percentage point headwind from pricing. Is that still how you're thinking about it? And do you still think that this is a business that's a low to mid single-digit grower over time?

Rob, I think that's the right way to think about the business in aggregate, especially around the core, the center of gravity that we have with asset managers, right. That's our bread and butter. And so that real break that you described is how we've thought about the business and how we continue to think about the business. I think the evolution though is a couple-fold. One is around execution. So we've talked about how we've had more neutral net-new business instead of positives that we aspire to and that we've seen before. So we talked about execution just now around segments, regions, client, relationship management by size, right. So there's a whole execution focus that can help drives the incremental growth that we'd like. I think the other rubric that helps here is to think about the front office, the middle office and the back office because each one of those is growing at a different pace, right? Front office revenues, as our revenue pool are growing in the low double-digit range. Middle office, which is all that reconciliation that asset managers still largely do in-house, right, it's growing in the high single digits. And, yes, the core cost of the accounting is the part that's growing more slowly in the 3% or 4% range. But with those other areas growing faster and those other areas being sizable revenue pools, there's a real opportunity for us as we target the front-to-back Alpha proposition at that fragmented largely in-sourced area of the revenue pools in front and middle office to help accelerate growth. And as it's -- when it's done as a solution, it helps to bring along the custody and accounting product growth as well because it's really a package and solutioning sales. So I think there's a real opportunity there to accelerate some of the growth. And then the final one I tell you about is by specific areas that are growing a little faster than others. Alts for example, in the private space, quite a -- it's growing faster than that 4% on average. And so as we continue to weigh the firm towards some of the faster growth segments, continue to weigh towards the front and middle office, we see some opportunities, some growth opportunities that are faster than we've had in the past. But we need to do that as we continue to execute on our core, which is why we're so execution-focused, while we're driving some of those broader shifts around front-to-back and around some specific higher growth segments.

And maybe if I could just press on pricing a little bit more, you've done a really nice job working through the pricing headwinds of prior years. I'm wondering, if with the work and the progress you've made there, and the improvement that you've driven, could you have flipped that? Is it possible that pricing could, going forward, be 100 or 150 basis point headwind in the future?

We'll need to keep working on that. I think the company is night and day different than how -- where we were in 2018, 2019, when we saw some of those higher-than-usual pricing headwinds, whether it's the implementation of the executive sort of deal review committees, the pricing escalation, the sophistication we've come with, balance of trade. So we've become much, much more effective at pricing. I think the question over time is, as we continue to shift the center of gravity of our solutioning efforts towards the front and middle office and bring along the back office with that, are -- there are some opportunities to stabilize pricing even more. And we'll see. I mean that's certainly what we're striving to do. And then there are certainly some faster growth areas, whether it's some of the areas like, alts where pricing tends to be a little less determined, given the fast growth that we and clients are seeing some of the continued inflows in Europe and some of the cross-border activities, continue to support healthy pricing. So there are pockets. And so part of what we do is, we play defense where there are historical pricing trends, but at least they've been well controlled and continuing to shift the locus or the center of gravity of our offerings, of our revenues, of our growth towards some of these better growth areas, where I think, over time, there could be some progress and further progress on pricing. But time will tell. And we'll certainly keep folks apprised.